This chapter is from the book

Guiding Principles

In characterizing and developing strategies and leadership for perceiving, assessing, and managing risks associated with extreme events, it is useful to focus on a set of guiding principles. These principles apply not only to leadership in averting and responding to natural catastrophes but also to leadership facing other extreme events, whether terrorist attacks, financial crises, or governance failures. We briefly highlight these principles here:

Principle 1: Appreciate the importance of estimating risks and characterizing uncertainties surrounding such estimates. For developing the strategies and leadership for reducing and managing a specific risk, it is essential to have reliable estimates of the likelihood of the event and its consequences. Consider a business facing a decision on whether to invest $100,000 to make its property more fire resistant. An informed decision on whether to incur this cost depends on having accurate estimates of fire frequencies and likely losses. Its executives will be more likely to make this investment if they learn that the chances of a fire next year are 1-in-100 rather than 1-in-1,000, and if the likely property damage and business interruption would total $5 million rather than $500,000. The less uncertainty surrounding these estimates, the more confident the executives will be regarding their decision as to whether to undertake these measures.

Principle 2: Recognize the interdependencies associated with risks and the dynamic uncertainties associated with the interdependencies. Many factors contribute to extreme risk, and they are connected through ever-changing linkages. For disaster strategies and leadership, understanding the evolving interconnectedness can be very challenging because the linkages are often hidden or indistinct.

On December 21, 1988, Pan American flight 103 exploded near Lockerbie, Scotland. In Malta, terrorists had checked a bag containing a bomb onto Malta Airlines, which maintained minimal security procedures. Airport personnel transferred the bag at Frankfurt's airport to a Pan Am feeder line, and personnel at London's Heathrow airport in turn loaded the bag onto Pan Am 103. The bomb was designed to explode above 28,000 feet, a flight altitude normally attained over the Atlantic Ocean, though not over Europe. Terrorists had deliberately exploited widely varying security procedures in place across the airports and airlines. Measures to prevent an aircraft disaster were only as strong as the weakest link in the system.13

Relationships among these interdependencies evolve over time, and measures to thwart their catastrophic impact on others may become inadequate later on. Airport authorities around the world improved security for bag transfers in the wake of the loss of Pan Am 103, but terrorists did find other ways of working around airline security measures, as the world learned on September 11, 2001. And even though government regulators in a host of countries tightened their rules in the wake of the financial crisis of 2008, new forms of systemic risk may nonetheless insidiously reappear beyond the reach of the new regulatory provisions. Evolving uncertainties point to the need for continuous vigilance and updating of risk-projection measures.

Principle 3: Understand people's behavioral biases when developing risk management strategies. Among the well-documented biases are misperceptions of the likelihood of catastrophic events, a focus on short-term concerns and returns, and a falsely optimistic confidence that a calamity will simply not happen on my watch—the NIMTOF (not in my term of office) phenomenon. Appreciating such biases is an important step for creating remedies and building cultures that can reduce or eliminate them. Many individuals, for instance, will not invest in protective measures for a property unless they believe they can recoup their investment in two or three years, even though the measures will be of benefit as long as the property stands. People often purchase insurance following a disaster, not before, and then tend to cancel their policies after a few years if they have not collected on their policy. Rarely do people concur with the principle that "the best return on an insurance policy is no return at all" (that is, no loss whatsoever).

Principle 4: Recognize the long-term impact of disasters on a region's or nation's politics, culture, and society. Catastrophes often create enduring change in areas far from the epicenter in ways that public and private leaders need to appreciate in taking preventive measures prior to a disaster and use to their advantage in developing strategies following a catastrophic event. The massive earthquake of 2008 in southeast China, for example, stimulated private charitable giving, attracted international support, and revised how Chinese officials view substandard schools, homes, and office buildings.

Principle 5: Recognize transboundary risks by developing strategies that are global in nature. Most disasters do not recognize political borders. The terrible Southeast Asia tsunami of 2004 killed residents of 11 countries. The Pakistan earthquake of 2008 left more than a thousand dead in neighboring areas of India. The failure of Lehman Brothers and the near collapse of other American banks in 2008 had catastrophic consequences for banks in dozens of other countries, from Britain and Iceland to China and Mongolia. One strategy to address and minimize risks is to have countries sign a treaty to reduce certain environmental risks, such as global warming or atmospheric pollution. There are potential benefits to all societies if enough countries take action, but there is also a net cost to any single country for adopting the treaty, as the United States argued at one point in refusing to sign the Kyoto treaty. What incentive is there for any one nation to adopt a treaty if it knows that a number of other countries will not join? How can policy makers and national leaders convince countries with leverage to sign the treaty to induce others to follow suit?

Principle 6: Overcome inequalities with respect to the distribution and effects of catastrophes. Whether natural or human caused, disasters often bring disproportionate hardships to those already at risk from low income or poor health. Public policies and private actions can help prepare a readiness plan on the part of those with more financial resources to support those in distress with fewer resources. Consider the flow of domestic and international assistance to China's southeast Sichuan Province in the aftermath of its great earthquake in 2008, with more than 69,000 dead (including 19,000 school-children), 274,000 injured, and 4.8 million homeless. The Chinese government invested more than $100 billion in the region's restoration, dispatched more than 50,000 soldiers and police to the area, and accepted humanitarian support from abroad, including South Korea, Japan, Russia, the United States, and even Taiwan. The Red Cross Society of China and many private organizations and individuals provided rescue and restoration equipment and funds (Yao Ming, of the Houston Rockets, donated more than $300,000.) Together, they helped thousands of families of modest means recover from the disaster. The experience points to the value of having government agencies and organizations such as the Red Cross prepared to provide assistance when it is most needed.

Principle 7: Build leadership for averting and responding to disasters before it is needed. The best time to create a readiness to face and overcome a low-probability, high-consequence disaster is before the event occurs. Leadership development is a time-consuming and labor-intensive process, and investing in it now can be seen as a preemptive and cost-effective measure to ensure that the six principles above are turned into active practice.

Had American financial institutions and regulators taken greater care to understand the growth of systemic risk in the U.S. housing and derivatives market, and had they created a greater readiness among their leaders to anticipate sharp downturns in those markets, the deep recession that the systemic risk caused in 2008 might not have reached such a depth. The failures of a host of banks, insurers, and manufacturers might have been averted, and the jobs of millions in the United States and abroad might have been saved.

The risk-management strategies and guiding principles we have identified here are intended to furnish a foundation for public and private policies and practices for preventing and reducing losses from low-probability, high-consequence events. The chapters that follow expand and draw upon these strategies and principles for catastrophic risks ranging from natural disasters to financial crises, and they provide guidance to leaders in all institutions for designing and developing measures to reduce losses and create a sustainable recovery in the wake of a catastrophe.